Friday, April 08, 2011

Price & Retailer Margin

Assuming price is determined by the demand and supply rules, how does one decides the retailer margin?

Let P be the price and M% be the retailers margin and C the expected number of units sold per month, then

Earnings per month for retailer = P * M * C
This number should be high enough to make a living for the retailer after deducting the cost of running the business.

Examples:

Mobile prices are high and number of units sold per month is good, causing margins to be low

Taps, shower, lights, basins, etc are sold at low volumes, prices are OK and margins are very high

FMCG products have very low margins

Kitchen chimneys and burners are high priced, volumes are low and margins are high

Cigarettes have high volume and hence margins are low

High end cosmetics have very low volumes, hence has reasonable margins

Books have low volume, unit price is OK, margins should be high

Text Books have high volume, unit price is OK, but they are sold only once in a year, very much like crackers on diwali.

Pet food also has low volume and hence high margins

Furniture again low volume, high price and hence margins ought to be reasonable.

I guess the opportunity for e-commerce is creating business efficiency for low volume products to drive their prices down by passing on the profits to customers making it impossible for some of the retailers to justify their business. The high volume products will always have lower margins and hence price is not what will drive buying on the net, but the other factors like trust, service, range, etc. It also opens up the market for products which couldn't find retail space because they couldn't fulfill this equation.

Another side effect of this equation is what will be counter intuitive for most economists. Under specific circumstances, when the demand goes low, prices don't really go down, they increase. The reason - retailer needs to meet his monthly needs. If he makes less money, the only way to go back to original income levels is increasing the price and not decreasing the price. The specific circumstances are:

All retailers are friends (taxi operators, unions, etc)

Customer lifetime values is same as that of current transaction. For example a tourist hiring a taxi is not going to remember or call the same guy on his next visit.

How much time does customer has to make the decision. The lesser the time, less choice he has.